Against the Grain

ATG Investments

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Anyone who knows me well can attest that the world of science is not my strong suit. I managed to get through AP Chemistry through rote memorization and very little practical understanding of what on earth a “mole” or “Venn diagram” really means. If you want help on a paper maiche volcano or an explanation of what a gallbladder actually does, I am not your man for the job.

This is probably why I’ve always been under-allocated to science and healthcare-related stocks in my investment portfolio. I have no common sense gauge to judge the risk of a business or how they might stack up to their competition. With specific regards to biotech firms, I’ve always wanted to invest in them but the idea of relying on proprietary cures for diseases and ailments after years and years of regulated testing truly scares me.

Having said all of this, the ATG portfolio needs at least some healthcare/ biotech exposure. I’m going to have to get over my personal insecurities in the sector and rely on (i) external research and feedback and (ii) a review of their basic financials to select a security for the portfolio. After some basic screening, we are deciding whether to open a position in Gilead Sciences, Inc. (GILD).

GILD has been on my radar for a while through a personal connection. I have a friend who has worked for GILD for several years- unfortunately his frequent comments on the rapid growth and success of the company never quite resonated above the bar-room chatter about girls, sports, and who knows what else.

He directly recommended the stock to me again back in March 2014 (when it was around $70/ share) because the biotech stocks were getting hammered and he thought GILD’s earnings would pop with the release of their Hepatitis C drug Sovaldi. I didn’t bite simply because the P/E was still scary high and I couldn’t justify taking a flyer on a new drug release. When GILD reported Q1-14 earnings in April 2014, I wish I had trusted my friend’s inside perspective- GILD earnings tripled from the prior quarter with a 62% upside surprise to consensus estimates.

Ever since then, GILD has been on a tear to the point where their earnings (both on a trailing 12 months and forward year) now suggest value-stock pricing (14 trailing P/E and 10 forward P/E). Below is a charge of their earnings growth over the past three years:

In addition to an attractive P/E ratio, GILD has negligible debt, ample free cash flow, and a gaudy return on equity. Additionally, a few different research reports I read about the company alluded to their market-leading and “strong economic moat” position in Hep C and HIV treatment drugs. Sounds awesome, right?

Well, after a little juvenile research on their business I did find one red flag that causes me some concern. It turns out that one of their main money makers, the Hep C drug Sovaldi mentioned above, literally costs $1,000/ pill, which translates to over $80k for a basic treatment. In fact, they have a newer Hep C drug called Harvoni that will cost even more! Here’s where I get nervous- maybe their Hep C drug is so superior that the market simply has to accept this pricing. On the other hand, I can’t see Obamacare being down with covering that level of cost. If they drop the hammer, the universe of people that can pay for the treatment out of pocket is probably equivalent to the current number of Weight Watcher members (sorry- that’s a deeply painful, inside joke).

ATG needs some biotech/ healthcare exposure and I’m still intrigued by the stock- the financial metrics are right up our alley and analyst coverage on the stock remains fairly bullish from what I can tell. But my personal science background inadequacy and the $1,000 pill is giving me hesitation- please reach out to me if you have any advice or thoughts on this stock (or a better one in the sector)!!

I don’t think I could ever work for a macro-strategy investment company. When I hear about investment ideas centered around relative currency strength, anticipated interest rate movement, commodity prices, and yes, world-wide oil supply/ demand, my head starts to spin and I have trouble seeing the forest from the trees. I’m much more comfortable opining on whether I think people would prefer to eat a Big Mac or Whopper (and who has a better balance sheet) than what’s going to happen to worldwide beef prices because of the political situation in Brazil. That doesn’t mean that I don’t at least try to understand macro issues and their implications; rather, I try to know my limitations and keep the faith that my investment strategy will eventually weather various macro storms I don’t fully understand if I can find good value in great long-term businesses.

With oil prices down almost 50% in the last six months alone, every investment expert is weighing in with their view on how this will affect the market. It’s a complicated issue- obviously lower gas prices for consumers is great in that people can spend their money on other things and great for countries that rely on importing gas, but it’s not so great if energy-related loans start defaulting and impacting banks or the U.S. loses a big chunk of the previous job gains over the past 5 years that were energy related.

My conclusion on this whole issue is that I simply don’t know what’s going to happen with oil prices and how it will affect the overall market, so I’d like to explore opportunities within the market that are less impacted by oil prices (or ideally not at all impacted).

Below are some of my thoughts on stocks/ themes that meet two criteria: (i) I think they are good stand-alone investments ideas for 2015 and (ii) I don’t think that oil price movement (good or bad) will have a huge impact on their success or failure.

Battered down brand names/ re-positioning stories:

Weight Watchers (WTW): After a fantastic 50% run-up in the second half of 2014 due to new leadership, improved technology, earnings beats, and revised upward earnings estimates, the stock has mysteriously lost 30% in value over the past 3 weeks alone with no material news other than the fact that some people didn’t “like their new magazine layout”. I’m still a believer in what the new management team is doing and am looking forward to another nice run.

Hertz (HTZ): Despite being transportation related, I don’t think oil prices will swing the dial much for Hertz; it all comes down to whether the new leadership can execute a successful turnaround and restore investor confidence in their operations, strategy, and reporting. If they can, this stock has tremendous upside. If they can’t, you are at least left with an iconic brand name and infrastructure that is near impossible to replicate.

Lower-end consumer product and food companies:

YUM Brands (YUM): People might eat a little more junk food with lower oil prices, but a larger driver of growth for companies like YUM (parent company of KFC, Taco Bell, and Pizza Hut) is their ability to grow into new markets and take share from competitors. moMANon wrote a great piece on YUM and why he feels that the Pizza Hut re-branding has the potential to take some meaningful market share from its competitors and move the earnings dial for YUM.

Health/ organic oriented food companies:

Whitewave Foods (WWAV): The other day at the grocery store I was shocked to have paid more for a gallon of organic milk for my kids than I typically pay for a gallon of dairy alternatives like soy or almond milk. Oil prices won’t dictate whether people drink milk or diary alternatives, and Whitewave has been on fire with 10 straight quarters of beating earnings expectations, year-over-year revenue growth exceeding 40% and encouraging new partnerships in china to expand their reach. ATG is going long again on lactose intolerance.

High Tech:

My personal favorite play here is probably Corning (GLW), the leading manufacturer of durable glass for tv’s, phones, and tablets. I don’t have a great “ATG” theory of why they will outperform other than I just love the company, their market dominance, and ability to continue innovating over the past 100+ years. Google (GOOGL) also feels cheap to me right now, but if oil prices cause an overall market shock downwards for some reason, I could see the mega-cap, high trading volume companies getting crushed simply from investor fund withdrawals.

Non-equity income and dividend plays (non-energy related of course!):

There’s nothing wrong with parking some money in non-equity dividend plays if you are nervous about energy prices rocking the market. Within the ATG portfolio we have increased our allocation to iShares U.S. Preferred Stock ETF (PFF), a large basket of predominantly bank-related preferred shares that are currently yielding 6.33%. If low oil prices were to trigger bank defaults, PFF would certainly be impacted, but not nearly as much as the underlying equities would be impacted.

With over 3,000 publicly traded companies in the U.S. alone and who knows how many mutual funds and ETF’s, investors have plenty of opportunities to pick their spots and limit exposure to certain factors of their choosing. I’m not staying away from the market, but I am staring away from big oil price bets in my personal portfolio for now.